This week’s inflation headline was the happiest one Canadians have seen in, literally, years. But it didn’t tell the decision-makers at the Bank of Canada what they need to know.
Statistics Canada’s monthly consumer price index report showed that the 12-month inflation rate fell to 4.3 per cent in March, the lowest since August, 2021. Of course, in August, 2021, inflation was rising, not falling, so that particular headline wasn’t happy news at all. Funny how hitting 8 per cent on the inflation thermometer, as Canada did last summer, can flip perspective on its ear.
When was the last time the inflation rate was falling in great leaps – down two percentage points, now, in the past three months – and the institution responsible for controlling inflation, the Bank of Canada, was cheering it on? At least 20 years. On this scale, more like 30. (There have been a few other sharp declines in inflation, but they have tended to accompany recessions and other economic unpleasantness.)
Bank of Canada Governor Tiff Macklem and his colleagues weren’t disappointed in the headline, either. They want the country’s overall inflation rate to keep falling as much as the next guy. Maybe more.
Problem is, the March CPI headline largely reflects what the central bank already knows about inflation. It knows that the cost of gasoline has come way down from where it was a year ago, when the war in Ukraine had sent global oil prices soaring. It knows that the greatly improved health of supply chains has eased pressures on a wide range of consumer goods. It is well aware that its own sharp increases in interest rates has cooled demand in general, and especially in the housing market. And it can see that over the next few months, the current price environment will continue to look even softer compared with the rising prices of a year earlier.
All of that is why Mr. Macklem keeps saying (several times in the past week, in fact) that the bank expects inflation to retreat to 3 per cent by midyear.
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But what the central bank needs to see to convince it that the next step is at hand – the step from 3 per cent to the bank’s target of 2 per cent – is not apparent beneath March’s happy headline.
Critically, inflation on the services side of the economy is proving stubborn. It was 5.1 per cent in March, compared with goods inflation of just 3.6 per cent. While the goods inflation rate has plunged nearly three percentage points since January, services inflation has slipped a thin 0.2 of a point.
The other things the central bank is looking for are not contained in the CPI data at all. It wants to see a slowdown in wage growth. It wants businesses’ pricing behaviour to “normalize.” Crucially, it needs consumers’ elevated inflation expectations to retreat.
The bank will have to wait for its own quarterly business and consumer surveys for fresh signals on those business and consumer sentiment questions. It will begin collecting data on both in a couple of weeks, although the results won’t be published until late June.
This is an area where those good-news inflation headlines could actually prove useful.
Last week, Stephen Poloz – Mr. Macklem’s predecessor as Bank of Canada governor – told BNN Bloomberg that as the overall inflation rate continues to retreat, the visibility of that decline in the news will help bring inflation expectations down, too.
“That’s what people see. That’s how they form their expectations,” he said.
But until that actually happens, it’s just an expectation of an expectation, a couple of steps removed from hard data. And given that it’s been four decades since inflation was as high as it was in 2022, it’s hard to say just how quickly expectations will respond to the ebbing of that inflationary wave – even a dramatic and highly publicized one.
It won’t help that one of the last holdouts in this inflation downturn is the price of food. Year-over-year grocery inflation is still running at nearly 10 per cent; over the past three months, the annualized pace is more than 12 per cent.
Food is a high-visibility, high-frequency purchase. When prices in the grocery aisle are still ballooning at a double-digit clip, it will be hard to convince consumers that inflation has been licked. A headline in a newspaper doesn’t carry the same visceral punch as the register at the supermarket checkout.
We may also be a few steps removed from an easing in wage pressures. Employment has increased for eight consecutive months, and job vacancies remain far above historical norms. The strike that began among federal workers Wednesday – with unions seeking annual wage increases ranging from 4.5 per cent to 7.5 per cent – may be indicative of a broader push among workers to recover the income power that they lost to inflation over the past two years.
Until we start to see slack in the labour market that will temper wage demands, and a cooling in food inflation and service-sector prices, the risk remains that declining inflation will stall. That’s the focus of the Bank of Canada. The happy headlines are welcome. They’re just not enough.